For years the top record label executives have been claiming that it's impossible to compete with free, but YouTube is proving them wrong. With billions of views every month the major record labels are making millions by sharing their music for free. For many people YouTube takes away the incentive to 'pirate,' but at the same time it may also cannibalise legal music sales.

The music industry has witnessed some dramatic changes in recent years, even when piracy is left out of the picture. In just a decade the Internet and the MP3 revolution have redefined people’s music consumption habits.

We’ve previously documented how people moved from buying albums to buying singles. But there’s another big change that occurred, one that may have an even bigger impact on the music industry as a whole; YouTube and other ‘free’ music sources.

If we go back in time 5 or 6 years, people had only one option if they wanted to listen to their favorite artists online without paying for the pleasure. That one option was piracy. Today the public has a wide variety of legal options, and the medium of choice for most people appears to be YouTube.

Although true music aficionados are hard to please, the majority of the public appreciates the option of listening to their favorite tunes for free on YouTube. Google is not complaining either, as music videos are a substantial revenue source for them.

But what about the record labels, are they happy too? This is not an easy question to answer, but we’re going to give it a try.

Revenue wise YouTube and Vevo have be come a serious revenue source. The major labels haven’t been very open about their revenue sharing deal, but EMI Music chief financial officer Paul Kahn said (pdf) during the LimeWire trial that his label gets half a penny for each YouTube play.

Half a penny may not sound much, but with billions of views it adds up quickly.

If we look at David Guetta, one of EMI’s top artists, we see that his YouTube uploads were viewed 308,000,000 times over the past 12 months. That means $1,540,000 in revenue, for only one artist.

Just as a comparison, Guetta and EMI have to sell more than 2 million singles to earn that much from ‘paid’ music.

In their latest report music industry group IFPI write that at the end of last year the major record labels were getting 1.7 billion views a month, and this number is rising rapidly. In the last 12 months alone Universal Music tripled the number of YouTube views from 2.3 billion May last year to nearly 7 billion today.

Staggering numbers that bring in tens of millions of dollars at least, with free music.

In part YouTube’s success goes at the expense of music piracy. With free music on YouTube a large group of people have less incentive to pirate, and indeed, the number of people who share music on BitTorrent appears to be slowing because of these and other alternatives.

This doesn’t mean that music sharing BitTorrent communities are fading away, but the more casual downloaders have found an alternative in YouTube and other streaming services.

That’s great news for the labels right? Well not so fast.

All those billions of views on YouTube each month may have slowed piracy down, but if we have to follow the logic of the music industry then actual sales of recorded music would also be affected. After all, for years they’ve claimed that “free music” on pirate sites caused billions in losses. Free music on YouTube should have a similar effect.

The big question is of course whether the revenue from YouTube can match these alleged losses or not. Not an easy question to answer, but these are crucial factors that define how the major record labels will fare in the coming years, probably even more so than piracy.

TorrentFreak asked both the RIAA and BPI to share their thoughts on how YouTube could affect music sales, but both unfortunately withheld their comments.

This leaves us with the conclusion that, unlike many record label execs have argued in the past, you can compete with free. You can even compete with piracy. Whether the net result is going to be a positive one has yet to be seen, but YouTube is taking up a larger chunk of the record label revenues each year.